As the pandemic rocked the US economy in 2020, markets nevertheless performed well, buoyed at the end of the year by the promise of effective vaccines and the prospect of better times to come.
The year did not begin well in the markets; stocks plunged in the early days of the COVID epidemic. But they recovered quickly after the Federal Reserve cut rates and restored Quantitative Easing and Congress passed the CARES Act in March. Ultimately, all the major markets we track outperformed their three-, five- and ten-year averages. Large-cap US tech stocks led the way earlier in the year, but were outpaced by small-cap and foreign stocks in the final months of the year. Likewise, value stocks outperformed growth over the final quarter.
The shift can be seen clearly looking at the five largest stocks that make up about 22% of the S&P 500: Alphabet (Google), Amazon, Apple, Facebook, and Microsoft. For the majority of the year, these large, technology-focused companies accounted for most of the return of the market. However, since August, most of their stocks have fallen slightly, while the markets have risen more broadly.
Many find it puzzling that the stock market has performed so well in a year of such seemingly relentless turmoil and bad news. One reason is that the indices that are cited most often, like the S&P 500 or the Dow Jones Industrial Average, are largely made up of seasoned companies with strong balance sheets, in contrast to the small businesses that have suffered so through the last year. In addition, these indices generally have large components of tech companies, which have fared better than many other businesses.
Another reason, and possibly the most important one, for stocks soaring in 2020 is the near-zero level of interest rates. In March, the Federal Reserve pushed the Fed Funds rate down to 0.00%-0.25%, the lowest level since November 2015. A declining rate environment is usually conducive for stock market returns. In contrast to the current ten-year Treasury bond annual rate of 0.93%, the current dividend payout of 1.57% on the S&P 500 looks attractive to investors. (And though fixed-income returns will probably remain low for several years, bonds are still an important component of most portfolios as they provide liquidity and stability through volatile times.)
Finally, the stock market and the economy are simply two different things. The stock market is focused on the future, and future earnings prospects. Stock performance tends to turn as soon as you can see a light at the end of the tunnel.
The economy, however, is still in the tunnel, struggling to bounce back from GDP losses of 5% in the first quarter and a whopping 31.4% in the second quarter of the year. There has been some recovery—with GDP growing 33.1% in the third quarter and 2.8% in the fourth quarter, as projected by the Conference Board—but for 2020 as a whole, US GDP is expected to have fallen 3.6%.
Meanwhile, earnings for the S&P 500 are projected to have declined 14% in 2020, according to FactSet, but are expected to rise 22.1% in 2021. Unemployment has fallen from its peak of 14.7% in April to 6.7% in November. More than 16 million have once again found work, but more than 9 million fewer people are employed compared with the end of 2019. Of the 20 million people receiving unemployment benefits, two-thirds are covered by CARES Act relief plans that were just extended through March 14 by the stimulus bill passed by Congress on December 21. It will likely take years, and additional Congressional support, before the economy returns to peak employment.
Playing out against the economic and public health turmoil, politics in 2020 provided additional drama. Joe Biden was eventually named the president-elect after several days of vote-counting, though controversy continued into 2021. As we go to print, it appears that both Democratic candidates will win the January 5 run-off election in Georgia, giving Democrats control of the Senate and therefore, all three branches of government. As Ben Rose highlighted in his article on the 2020 election last quarter, while the market has historically performed best when government is divided, the market has also performed well in cases of one-party control. All eyes are certainly on Washington as we near the inauguration.
As happy as I am to see 2020 in the rear-view mirror, we are likely to still be living with the pandemic for much of 2021. The vaccines from Pfizer, Moderna and AstraZeneca-Oxford offer a great deal of hope for returning to “normal,” but several factors will figure in, including production capability, effectiveness against virus mutation, and the willingness of people to be inoculated.
A new administration will also bring changes. Presidents typically try to make their mark in their first hundred days in office. President-elect Biden has voiced his willingness to work closely with the medical community. Stricter guidelines from the federal government could slow the pandemic spread, but also the economy in the short run.
The trend away from globalization accelerated in 2020 as trade faltered during the pandemic. Before the outbreak, China had effectively ended trade talks until after the US election, thinking any president other than Trump would offer a better trade deal. President-elect Biden has said he will be tough on China, a rare point of agreement with Trump. Meanwhile, Biden has indicated his intention of rebuilding traditional alliances around the world.
Looking back on our experience during a trying year and the experiences of our clients, we can see that maintaining discipline paid big dividends. We put a lot of research and a good heap of humility into building our portfolios. We did not foresee the COVID epidemic and its impact on our daily lives. Even if we had, we probably would have expected worse investment results than we’ve experienced.
The good news is that we were prepared. Our clients hold diversified portfolios to weather falling markets and benefit in rising ones. We don’t make sweeping changes to our portfolios, but we rebalance opportunistically to add to stocks when prices are low and take profits off the table when prices are up. We will do our best to continue to do this regardless of what comes in 2021 and beyond.